Read a company’s statements in one direction: revenue falls to profit for the year, and profit for the year feeds retained profits. Tax comes off before profit for the year, and dividends come off after it.
This lesson belongs to the limited companies chapter. It assumes you can already place items, as shown in distinguishing share capital, reserves and liabilities.
Where does the profit go?
Think of profit as water moving down three tanks. The first tank holds gross profit, the second holds profit before tax, and the third holds profit for the year.
From there the water splits. One part goes out as dividends to shareholders. The rest is kept as retained profits, and that is what the statement of financial position shows.
Worked example: Kasturi Trading Berhad
Kasturi Trading Berhad has these figures for the year: revenue RM480 000, loan interest RM6 000, income tax RM16 000, distribution expenses RM40 000, administrative expenses RM62 000 and RM290 000 as cost of sales. Opening retained profits are RM30 000 and dividends paid are RM25 000.
Statement of profit or loss
| Line | RM |
|---|---|
| Revenue | 480 000 |
| Cost of sales | (290 000) |
| Gross profit | 190 000 |
| Distribution costs | (40 000) |
| Administrative expenses | (62 000) |
| Loan interest | (6 000) |
| Profit before tax | 82 000 |
| Income tax | (16 000) |
| Profit for the year | 66 000 |
Retained profits
| Line | RM |
|---|---|
| Opening retained profits | 30 000 |
| Profit for the year | 66 000 |
| Dividends | (25 000) |
| Closing retained profits | 71 000 |
The profit for the year is 13.75% of revenue, because 66 000 ÷ 480 000 = 0.1375. Of the RM66 000, RM25 000 was paid out and RM41 000 was kept.
The mistake that costs marks
The common slip is to deduct the dividend along with the expenses, because money leaves the company. The dividend is a share-out of profit, not a cost of earning it.
| Step | Wrong | Right |
|---|---|---|
| Treat the dividend | Expense in the profit statement | Deduction from retained profits |
| Profit for the year | 66 000 − 25 000 = 41 000 | 66 000 |
| Closing retained profits | 30 000 + 41 000 = 71 000 | 30 000 + 66 000 − 25 000 = 71 000 |
Notice that the closing figure is the same, which makes the error easy to miss. The marks are lost because the profit for the year shown is wrong.
How do the statements connect?
The closing retained profits of RM71 000 go into the equity section of the statement of financial position, beside share capital and any reserves. If the statement does not balance, check that you carried this figure across and did not use the profit for the year instead.
You can practise connecting the statements with the debit-credit transaction trainer.
Check yourself
A company reports revenue RM350 000, expenses RM70 000, income tax RM12 000 and RM210 000 as cost of sales. Opening retained profits are RM15 000 and dividends are RM20 000. Find profit for the year and closing retained profits.
Answer
Gross profit = 350 000 − 210 000 = RM140 000.
Profit before tax = 140 000 − 70 000 = RM70 000.
Profit for the year = 70 000 − 12 000 = RM58 000.
Closing retained profits = 15 000 + 58 000 − 20 000 = RM53 000.
What to study next
Next, learn the journal entries behind these figures in recording permitted capital transactions within scope.
If you want a teacher to go through company statements on your own practice questions, see online one-to-one Accounting tuition.